“Given that were in a hard market right now and terrorism [coverage] is not available, how might that impact alternate risk-transfer mechanisms?” he asked during a session at the Casualty Actuarial Societys meeting in San Diego devoted to issues arising since Sept. 11. He wondered aloud if the alternative market would grow to fill the void.

If they do, then that would constitute very na?ve capacity, contends James Bonica, managing director and casualty practice leader for Marsh Inc., drawing a parallel to recent events in the medical malpractice market.

The St. Paul, one of the largest medical malpractice writers in the country, “punted,” he said. The company said it couldnt “get a handle on this. Theres too much going onto quantify that risk,” he added, noting that the exposure is migrating to risk retention pools and other ART mechanisms.

The message is even louder with respect to terrorism insurance, according to Mr. Bonica and other speakers at the CAS meeting, referring to the fact that insurers cant possibly get a handle on the frequency and severity of potential terrorism losses.

Robert Graham, senior vice president and assistant general counsel for General Reinsurance Corp. in Stamford, Conn., finished the argument against ART solutions to replace terrorism insurance.

“One reason ART tends to work is because the retained risk is something that you think you understand, and the reinsurance market stands behind you to take care of the excess,” he explained. “Here, what youve got is most of the reinsurance market saying, We dont understand it. Were not going to underwrite and price it, and therefore were not going to cover it.'”

In that environment, he added, “putting it into an alternative risk-transfer vehicle, then, is kind of toxic. Its terribly na?ve capacity if they think that just by getting together with a bunch of other people that have that exposure, its going to solve the problem.”

What about the capital markets stepping in to securitize the risk, Mr. Graham was asked. “If alternative risk-transfer vehicles are na?ve capacity, then securitization is the ultimate in na?ve capacity,” he said.

“The folks who have done securitizations to date typically rely on [organizations like General Re] to underwrite and price the risk, and to give, in effect, a seal of approval to the risk underwriting and risk management associated with the perils being insured through the securitization products,” he explained. But since terrorism isnt a peril that reinsurers can meaningfully underwrite and price, he predicted that there wouldnt be too many reinsurers willing to give out such stamps of approval.

He also said that securitization works best with lines that are not long-tailed, because investors in these deals dont have long time horizons.

Marsh's Mr. Bonica concurred that the “cat bond market” does not exist for the terrorism peril.

ISO's Mr. Kollar noted that one of the critical circumstances that must be in place for securitization to work is a level playing field of information for issuers and bond buyers. “If no one is going to have an advantage over you, then maybe you might be willing to gamble,” he said, offering the only possible argument in support of the hypothesis that securitization could work to cover terrorism that was offered during the session.

“On the terrorism exposure, everyones equally ignorant. Thats as level a playing field as you can get,” Mr. Graham said, agreeing with the characterization of the buyer of a terrorism insurance bond as a gambler.

Later in the session, he noted that in the property-catastrophe bond market, where there is far less uncertainty with respect to severity and frequency of loss, “the capital markets have chosen not to play with respect to insurance risk.” Adding that the notion of insurance securitizations has been around for about 12 years, he said, “their acceptance to date has been a fairly miniscule number.”

“Insurance risk is probably the ultimate junk bond,” Mr. Bonica said.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, June 10, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.